SBA Bid Protest: Two Classes of Stock and SDVOSB Eligibility

The Small Business Administration (SBA) bid protest in question arose out of a Department of State request for proposals for an aviation program support service. The contract was a Service Disabled Veteran Owned Small Business (SDVOSB) set aside and Precise Systems Inc. was the apparent winner. Four companies, All Points Logistics, LLC; AMPS, LLC; B3 Solutions, LLC; and Downrange Operations and Training, LLC, filed a SBA bid protest alleging that Precise Systems was not unconditionally and directly owned by a service-disabled veteran due to its Employee Stock Ownership Plan (ESOP). The Acting Director of Government Contracting (AD/GC) sustained the protest. Precise appealed the AD/GC decision to the Office of Hearings and Appeals (OHA). In sustaining the SBA bid protest, the AD/GC stated that “in order for a corporation to qualify as an SDVO SBC, at least 51 percent of the aggregate of all stock outstanding and at least 51 percent of each class of voting stock outstanding must be unconditionally owned by one or more service-disabled veterans.” (Internal quotes omitted) (citing 13 CFR §125.9 (d))

Function Over Form?

Precise argued in its defense that it only had one class of outstanding stock because all outstanding stock was entitled to one vote per share. The AD/GC retorted that it was the function of the structure rather than the form of the structure that mattered. It found further that Precise had two groups of shares with separate voting rights on at least one issue and that the Series B Convertible Preferred was granted a preferred dividend right. The AD/GC concluded that the disabled veteran, Mr. John Thomas Curtis, held all of the Series a Common Stock, as well as the majority of total outstanding stock, but he held none of the Series B Convertible Preferred Stock and therefore did not own at least 51 percent of each class of voting stock as the regulation required.

Regarding control, the AD/GC found that Mr. Curtis met all of the requirements of control including being the highest officer in possessing the managerial experience necessary to run the concern; was a member of the Board of Directors; and had the necessary ownership interest overcome any supermajority voting requirement. However, the AD/GC determined that Mr. Curtis did not control Precise despite meeting all of the requirements. The SBA OHA remanded on these narrow grounds opining that the AD/GC’s determination on this issue may have been a typographical error.

Precise’s Arguments on Appeal

In its appeal to the SBA OHA, Precise argued that the AD/GC’s determination that it had two classes of stock was clearly erroneous and should be reversed. Specifically, the company argued that its articles of incorporation directed that both series of stock should vote together as a voting class. Also, Precise’s bylaws confirmed that each shareholder held one vote and that quorum was satisfied with the majority of outstanding shares, regardless of series. Precise argued that Mr. Curtis had the power to control the company because he owned the majority of the total outstanding shares, was a controlling member of the Board of Directors, and could establish quorum based on his shares alone.

Maryland Law

The SBA OHA, in upholding the AD/GC determination, pointed to Maryland’s Corporations and Associations Code, which states in part “if the stock is divided into classes,” the corporations governing documents must include “a description of each class including any preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends, qualifications, and terms and conditions of redemption.” Md. Code Corps. & Ass’ns § 2-104(a)(7). The OHA concluded, “It follows from this provision that, although voting rights are a relevant consideration, the boundaries of a ‘class’ may also be defined by factors such as preferential dividends, redemption abilities, and conversion rights.” Administrative Law Judge Kenneth Hyde determined that the AD/GC did not err in considering factors other than voting rights in assessing whether the Appellant has one or two classes of stock.

VA Law

Precise also pointed to VA Law, at 38 CFR § 74.3 (a), which specifically exempts ESOPs, in trying to persuade the OHA to reverse the A D/GC’s determination. The ALJ retorted that the SBA’s program contained no such exemption and there was no legal basis for the OHA to read in such an exception. He similarly dismissed Precise’s policy arguments that sustaining the AD/GC decision would discourage companies from forming ESOPs. “It is well settled that OHA has no authority to determine the propriety of the regulations themselves.” The ALJ instructed that such concerns should be directed to SBA policy officials.

OHA Conclusion

The OHA denied Precise’s appeal but agreed with its assertion that the AD/GC erred in determining that Mr. Curtis, the service-disabled veteran, did not control his company and reversed that portion of the determination. However, that was a hollow victory, because the OHA determined that the AD/GC did not err in determining that Precise did not meet the eligibility criteria under 13 CFR §125.9 (d). The OHA concluded that Precise had two classes of stock, and one of those classes was not at least 51 percent owned by the service-disabled veteran. There is no indication that Precise appealed this decision to the U.S. Court of Federal Claims, which has jurisdiction in these matters.

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